Market View

Undercover Economist

A measure known as purchasing power parity, which suggests the value of a currency based on what it can buy in another country, pegs the loonie at just under 85 cents, below where it now sits and well below where it had been before a year-long devaluation that picked up remarkable speed this month.

It lost almost 7 per cent last year, and eroded even further in the past few weeks amid soft economic reports and a “dovish,” or easy-going, Bank of Canada under its new governor, Stephen Poloz.

Chief currency strategist Camilla Sutton noted today that there has a been a “material re-pricing” in currency markets since the U.S. dollar bottomed a year ago.

The Australian dollar, for example, has declined by 17 per cent, Japan’s yen by 14 per cent, and the Norwegian krone by 10 per cent. In the same period, the loonie is down 11 per cent.

“As these currencies have depreciated, their longer-term valuations have moved back towards fair value,” Ms. Sutton said today.

“Purchasing power parity (PPP) suggests that CAD has shifted from being overbought in early 2011 to relatively close to fair value; while AUD remains overbought but has dropped from its exaggerated levels,” she said, referring to the Canadian and Australian currencies by their symbols.

“Typically, we do not put a lot of weight in PPP as currencies can remain overbought for years (AUD makes a great example of this) and our two-year forecast horizon is too short for PPP to provide value,” she added in a research now.

“However, as CAD is now the least overvalued of all the primary currencies it does suggest that from a traditional medium-term valuation approach, downward pressure on CAD might shift to some of the other currencies that remain notably overbought.”

On that last point, she cited the euro and Swiss franc.

Ms. Sutton isn’t alone here.

Chief economist Douglas Porter of Bank of Montreal, citing the commodities that are key to Canada’s economy, made a similar observation last week, when the currency was just slightly stronger.

“With commodity prices holding up, we can actually say – for the first time in at least four years – that today’s Canadian dollar of just over 90 cents is close to ‘fair value’ based solely on resource prices,” he said.

“However, just as the currency traded well above fair value for years, it could just as easily move below fair value for an extended period.”

Acting after emerging market currencies were hammered last week, only to be calmed by the central bank’s emergency meeting today, it hiked its benchmark overnight rate to 12 per cent from 7.75 per cent. Other rates moved up as well, driving up the value of the lira.

“Recent domestic and external developments are having an adverse impact on risk perceptions, leading to a significant depreciation in the Turkish lira and a pronounced increase in the risk premium,” the central bank said in a statement after the meeting.

“The central bank will implement necessary measures at its disposal to contain the negative impact of these developments on inflation and macroeconomic stability. In this respect, the Committee decided to implement a strong monetary tightening and to simplify the operational framework.”

Monetary officials also warned that tight monetary policy “will be sustained until there is a significant improvement in the inflation outlook.”

It expects to reach a 5-per-cent inflation by midway through next year.

India’s central bank also surprised investors today with a hike of one-quarter of a percentage point in its key rate, a move against rampant inflation that underscores some of the troubles in emerging markets.

The rate now stands at 8 per cent.

“The gravest risk to the value of the rupee is from CPI inflation which remains elevated at close to double digits, despite the anticipated disinflation in vegetable and fruit prices,” said Raghuran Rajan, governor of the Reserve Bank of India.

“It is possible to bring inflation under control without a substantial sacrifice of short term growth, provided we do what is necessary, and are patient,” he added.

The move had not been expected.

“The rate hike occurs in a context of both: a) the recent bout of weakness in emerging markets (extreme weakness in some cases), and b) the general weakening of the INR over the past seven months and runaway inflation in the 10-per-cent year-over-year range,” said Derek Holt and Dov Zigler of Bank of Nova Scotia, referring to India’s rupee by its symbol.

What to expect from FlahertyCanadians should expect a “relatively minimalist” federal budget next month.

“I’m expecting a steady-as-she-goes budget,” economist Sonya Gulati of Toronto-Dominion Bank said after Finance Minister Jim Flaherty said yesterday he’d bring down his budget on Feb. 11, in the middle of the Olympics.

The two key themes, she said, will be “a focus on the economy and long-term prosperity” and a return to a budget surplus after several years in deficit.

“A few new spending initiatives will make their way into the budget, but they will likely be small, targeted and inexpensive,” Ms. Gulati said.

“Economic growth assumptions remain modest, which gives the government little unanticipated revenue windfall to play with. Tax hikes will likely be off the table, similar to past budgets.”

Chief economist Douglas Porter of BMO Nesbitt Burns agreed.

“All signs point to this being a relatively minimalist budget – very early in the year, during the Olympics, the year before an election, and no big changes or surprises on the economic backdrop,” he said.

“Finally, with still some work to be done before we reach the promised land of surpluses, there’s little room for new measures. Having said that, there is always at least one notable talking point in every budget, and this one may see more (minor) measures aimed at bringing down some targeted tariffs on specific goods.”

I now pronounce you … very richUnromantic as it is, “assortative mating” isn’t a phrase oft heard in the wedding chapel.

What it means is that the rich are marrying the rich – keeping it on the right side of the tracks, if you will – and by doing so are exacerbating income inequality.

Put another way, 1 per cent plus 1 per cent still equals 1 per cent.

A new American study, which tracked hundreds of thousands of families based on U.S. Census Bureau data from 1960 to 2005, finds that “positive assortative mating in the marriage market” increased as more women began working and couples hooked up along career and educational lines.

The study published this month by the National Bureau of Economic Research – “Marry Your Like: Assortative Mating and Income Inequality” – is an important one as the widening divide between rich and poor becomes such a key concern in the post-crisis era.

The working paper by Jeremy Greenwood, Nezih Guner, Georgi Kocharkov and Cezar Santos uses complex formulas – decidedly not what you'd call sweet nothings – to come to the conclusion that marriage can be a factor.

“In 1960 a household at the 10th percentile earned 16 per cent of mean income,” says the paper, also reported by The Wall Street Journal.

“This dropped to 8 per cent in 2005,” it adds.

“A household in the 90th percentile earned 251 per cent of mean income in 1960s versus 317 per cent in 2005. Incomes are more polarized in 2005. The change in wages across individuals is the primary driver of this increase in income inequality.”

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